Is It Time To Follow Buffett Into This 'Hated' Stock?

By (Poonkulali Thangavel),

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You've no doubt heard many times that one of the best ways to makemoney in thestock market is to buystocks when they're "hated." In fact,Warren Buffett has followed this path to profits countless times and used it to amass his vast fortune.

I don't think I could find many stocks that have been more "hated" over the past few years than Bank of America ( BAC ) . From its role in the financial crisis and housing bubble to ongoing litigationissues associated with those dark chapters for theeconomy , it seems like the company can't catch a break.

But, of course, just because a stock is hated doesn'tmean you should buy it. To determine this, we have to look much deeper.

But before we do that, the first and most obvious thing to consider is that none other than Buffett himself has issued a vote of confidence in Bank of America, as evidenced by his $5 billion stake inpreferred shares , which come with a steady 6%yield .

We don't have the luxury of getting a sweetheart deal like this, but we can look to some of his recent comments about the company to get a clue into his thinking on the current status of the company -- and Buffett has said Bank of America'smortgage issues are being addressed.

The stock's current price is considerably below itsbook value of about $20, but that discount accounts for the lack of clarity about the bank's future. For one, the company is still dealing with the fallout from subprime lending issues, largely tied to itsacquisition of Countrywide Financial, and the housing market downturn.

Most recently, the federal government sued Bank of America, accusing it of misleading investors in about $850 million of mortgage-backed securities. According to the suit, the bank led investors to believe that the securities were backed byprime jumbo mortgage loans and did not adequately disclose the risks involved. Earlier thisyear , Bank of America settled with mortgage financier Fannie Mae (OTC:FNMA ) over loans that Fannie claimed were substandard and wanted Bank of America to buy back.

Bank of America isn't alone in its mortgage issues: The bank committed tocash payments of $1.1 billion and other assistance of $1.8 billion in a settlement with other banks and the government to help mortgage borrowers withloan modifications.

The most recent government lawsuit comes just when Bank of America is cutting down significantly on its litigation expenses, which were $471 million in the second quarter, down from $2.2 billion in the first quarter and from $963 million in last year's second quarter.

Still, Bank of America reported good results for the second quarter, withnet income up 63% from a year ago, to $4 billion.Earnings per share ( EPS ) for the period were 32 cents a share, up 68% from last year. However,revenue was up a mere 3%, meaning thatprofit increase was achieved through cost-cutting and a reduction inloan loss reserves as the economy improved.

Bank of America's 2009 acquisition of Merrill Lynch is bearing fruit, with its globalwealth andinvestment management business division reporting second-quarter revenue of $4.5 billion, up about 10% from a year ago. The division's assets under management also increased, andasset management fees jumped 10%. The bank also reports that it is able to meet standards showing it has enoughcapital to weather losses.

Annualizing itsEPS for the second quarter, the company'sprice-to-earnings ratio is a reasonable 11.35, and its price-to-book ratio is an attractive 0.7. Although BAC's currentdividend yield is only about 0.3%, management could buy back as much as $4 billion in stock.

Risks to Consider: The major risk facing Bank of America stems from the liabilities related to its mortgage lending and securitization activities. While the improvement in the housing market means that the worst of the downturn is likely behind us, other claims could surface against Bank of America, particularly in connection with the subprime activities of Countrywide Financial, which Bank of America acquired in 2008.

Action to Take --> BAC is unlikely to test the lows it saw in early 2009, when it sank all the way to $2.53, down from more than $50 a share in 2007. And BAC does present considerableupside , considering it may regain its luster as the economy improves. Even then, what worked for Warren Buffett might not work for you, given the considerableheadline risk associated with BAC. Those enticed to buy by Bank of America's value proposition may want to wait a bit to see how things play out.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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This article appears in: Investing , Investing Ideas , Stocks
Referenced Stocks: BAC , EPS , FNMA

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